Recent Developments Regarding Majority Voting in Director Elections
By Patrick G. Quick, John K. Wilson, and Jessica S. Lochmann

The issue of majority voting for directors has become a widely discussed corporate governance topic. This is particularly true as companies head into the 2006 annual meeting season. Many public companies may feel pressure to consider their director voting standards—perhaps because of shareholder proposals under Rule 14a-8 of the Securities Exchange Act of 1934. This article addresses recent developments relating to the majority vote debate, including institutional shareholder actions and shareholder proposals, implications of changing from the plurality voting standard, corporate governance policy changes that some companies are adopting, and the recent policy update of Institutional Shareholder Services (ISS) on majority voting.

Background

In October 2003, largely at the urging of certain institutional shareholders, the Securities and Exchange Commission proposed proxy rule changes that would have provided shareholders with a limited right of access to company proxy materials to make it easier for shareholders to elect their own nominees to a company’s board.¹ These proposed rules were controversial, and over time it became clear that they would not be adopted. Notably, the staff of the SEC took the position that companies could omit from their proxy statements shareholder proposals based on the SEC’s proposed rules.² In light of these developments, certain institutional shareholders shifted their focus to changing the required vote for the election of directors. More specifically, ISS (a provider of proxy voting and corporate governance services) and various institutional shareholders initiated an effort to change the threshold for the election of directors from a plurality voting standard to a majority voting standard.

A plurality voting standard is the standard used in the election of directors under most state corporate laws. Under the plurality standard, a nominee is elected as a director by receiving the highest number of votes cast for an open director’s seat, even if that number is less than a majority. This means that only votes “for” a director candidate have any legal significance. As a result, a director nominee in an uncontested election needs to receive only a single affirmative vote to be elected. Even if holders of a substantial majority of the voting shares choose to “withhold” support for the nominee, the director nominee still is elected, rendering votes withheld only symbolic.

Under a majority voting standard, a director nominee is elected (or re-elected) only if he or she receives an affirmative vote of the holders of either (depending on the standard) a majority of the shares present and voted at a meeting or a majority of the total outstanding shares entitled to vote. Under this standard, “withhold” votes in the election of directors are significant to the extent the nominee fails to receive the requisite majority vote. For this reason, institutional shareholders, among others, prefer the majority voting standard.

Institutional Shareholder Action

In 2005, the Council of Institutional Investors sent a letter to 1,500 of the largest U.S. companies urging adoption of a majority voting standard.³ The letter stated that, if permissible under state law, a company’s charter and by-laws should provide for election of directors by a majority of the votes cast at an annual meeting. The letter further provided that, if state law requires plurality voting or prohibits majority voting for directors, then the board of directors should adopt a corporate governance policy mandating that a director tender his or her resignation if votes withheld exceed votes for the candidate, and providing that a director will not be renominated after the expiration of his or her current term if the director fails to tender such resignation.

In addition, many companies have received or will be receiving shareholder proposals from certain institutional investors advocating a majority vote standard. These proposals typically recommend that the board of directors take action to adopt the majority vote standard by charter amendment if the company is incorporated in a state that only permits changes through such an amendment. If the applicable corporate law and the company’s charter and by-laws permit voting requirements to be determined through a by-law amendment adopted by shareholders (which could be the case for many Delaware companies), the shareholder proposals proffer binding by-law amendments.

In general, the shareholder proposals recommending that the board take action tend to defer to the board to craft language that addresses technical aspects of the majority standard, including how to treat a failure to reelect an incumbent director and contested elections. These proposals are “precatory,” meaning they are not binding on the company because the shareholders do not have the corporate authority (without board approval) to propose for shareholder consideration an amendment to a company’s charter. The staff of the SEC has not permitted companies to exclude these proposals from their proxy statements on the grounds set forth in Rule 14a-8—including the provision that allows a company to exclude a proposal that relates to an election of directors.⁴ In fact, the staff has not allowed any company to omit from its proxy statement a shareholder proposal regarding majority voting. However, the staff has not yet formally advised on the subject of whether a company may omit from its proxy statement a proposal for binding by-law amendments to effect a majority voting standard.

According to ISS, shareholder proposals seeking a majority vote in director elections were considered at over 60 shareholder meetings in 2005.⁵ Sixteen of these proposals won the support of a majority of the shareholders; the average affirmative vote for all of these proposals was 44%.⁶ Corporate governance observers expect this to be one of the top shareholder proposals for the 2006 annual meeting season. In fact, ISS expects that more than 100 companies will receive majority election shareholder proposals. The United Brotherhood of Carpenters and Joiners alone has submitted majority election shareholder proposals to over 65 companies for the 2006 annual meeting season.⁷

Concerns with a Majority Voting Standard

There are many factors that a company may wish to consider before adopting a majority vote standard. The following are some of the issues.

Benefits of the plurality standard. There were reasons that state corporate laws adopted the plurality voting standard. Among others, plurality makes sense in an election in which there are more candidates than seats, for example, in a contested election in which people are running against management’s nominees. If the majority vote standard applied to a contested election and no candidates received a majority of the vote, then no directors would be elected.

Impact of other corporate reforms. Similarly, there have been many new corporate reforms, requirements, and limitations in the past few years. The benefits and costs of these changes are not yet completely understood, but they may prove to be sufficient to satisfy shareholders’ concerns. For example, recently added requirements for nominating committees ensure that the committees consist of independent directors and that the company discloses a number of matters concerning the nominating committee’s criteria and processes. It is possible that further changes, like altering the voting standard, are simply unnecessary.

Hidden agendas. Shareholders often vote against directors or withhold votes to further their own policy agendas rather than in response to the performance or qualifications of the director or for reasons that relate to long-term shareholder value. Accordingly, adopting a majority voting standard could give certain shareholders another way to advance their agendas and to attempt to micromanage a company. Long-term shareholders have other means to communicate with and influence management regarding bona fide business matters, including through direct communications. It could be a disservice to shareholders generally if a majority voting standard facilitated the ousting of directors for relatively inconsequential reasons.

Board composition requirements. Majority voting could cause a company to fail to comply with stock exchange or SEC requirements regarding board and board committee membership if the shareholders do not elect a sufficient number of independent directors.

Director recruiting concerns. Given developments affecting public companies and their directors, it has become increasingly difficult for companies to recruit directors. A majority standard may exacerbate the problem by providing another disincentive for directors to serve. In a related point, a majority standard can result in a sudden, binding removal of a director and a vacancy on the board. On average, it takes a company a year to find a suitable director candidate.

Expense. Majority voting is likely to result in more costs to public companies in terms of proxy solicitation expense and management time, adding to the burden of being a public company.

Holdovers. A majority voting standard does not address the so-called “holdover” concern: under most state corporate laws, an incumbent director will continue to serve until his or her successor is elected. Thus, if an incumbent director is not re-elected, then the director would nonetheless continue to serve until the company holds another election or the director resigns.

CEO-specific. The failure to re-elect a chief executive officer as a result of a majority voting standard could trigger a variety of problems, including potentially obligating the company to make payments under an employment agreement.

Is There a Compromise?

In the face of shareholder action, some companies are simply resisting majority election shareholder proposals or taking no action where proposals are successful. For example, Paychex Inc. recently defeated a binding shareholder proposal, which received only 18% of the shareholder vote. (In this case, ISS recommended a vote against the proposal because it did not distinguish between contested and uncontested elections.⁸)

A number of companies, including Pfizer and General Electric, have adopted majority withheld vote policies in their corporate governance principles or by-laws,⁹ perhaps in an attempt to reach a compromise and avoid having formal proposals included in their proxy statements. These policies feature a number of variations on the theme, but generally a director nominee receiving a greater number of “withheld” votes than votes “for” in an uncontested election must tender his or her resignation. The governance committee or the board then decides within a specified time period whether to accept the resignation, and the company publicly announces the result. The policies vary on factors such as whether they apply to contested elections (a policy may apply only if a majority of the shares outstanding withhold votes) and whether the decision maker should accept the resignation absent “compelling reasons.”

Some institutional shareholders have indicated that this compromise approach is not sufficient. For example, the United Brotherhood of Carpenters and Joiners has targeted with majority election shareholder proposals several companies that have adopted the Pfizer-like policies because the union does not believe such policies are responsive or adequate.¹⁰ The Council of Institutional Investors supports the majority voting default rule approach under which a director who fails to garner a majority of votes cast should be required to step down with no provisions for the board to overrule shareholders.¹¹

In at least one instance, the SEC has advised that the compromise approach is not sufficient to allow a company to exclude from its proxy materials a precatory shareholder proposal regarding a majority voting standard for directors. In a letter dated January 5, 2006, the SEC denied Hewlett-Packard Company’s request to exclude from its proxy statement a shareholder proposal requiring a binding amendment to “its corporate governance documents (certificate of incorporation or bylaws)” to implement the majority voting standard. Hewlett-Packard had attempted to exclude the proposal on the basis that the company had already “substantially implemented” the proposal by adopting corporate governance guidelines requiring a director nominee to tender his or her resignation for the board to consider if such nominee receives a greater number of “withheld” votes for his or her election than “for” votes.¹²

The Model Business Corporation Act currently contains a statutory default rule that calls for plurality voting in director elections unless otherwise provided in a company’s charter. In March 2005, the American Bar Association’s Committee on Corporate Laws of the Section of Business Law formed a task force to study the issue of majority voting and to recommend to the Committee whether to make changes to the Model Business Corporation Act with respect to the election of directors. The Committee issued a Discussion Paper in June 2005 that considered certain options respecting the current plurality voting default rule and a potential majority voting default rule.¹³

On January 17, 2006, the Committee released a Preliminary Report detailing possible amendments to the Model Act. The proposal, which was issued for discussion purposes, would not alter the statutory plurality default rule, but would instead allow a company’s board or shareholders to adopt a by-law amendment that would create a majority voting standard in director elections. The proposal would have the effect of allowing a director who received less than a majority of the votes cast in a shareholder election to remain as director for no longer than a 90-day transitional period, and also would allow the remaining directors to fill the resulting vacancy. In addition, the Committee’s proposal would facilitate the adoption of Pfizer-like corporate governance policies that require a director to tender his or her resignation upon failing to receive the required vote by expressly recognizing that a director may submit a binding, irrevocable resignation in advance and that a director’s resignation may be effective upon the occurrence of specific events.¹⁴

Current ISS Policy on Majority Voting

In November 2005, ISS issued its 2006 proxy voting policy updates.¹⁵ Those updates provide that ISS will “generally recommend” voting for reasonably crafted shareholder proposals calling for directors to be elected by an affirmative majority of votes cast. However, ISS will “consider” recommending voting against a majority election shareholder proposal if a company has adopted formal corporate governance principles that present a meaningful alternative to the majority voting standard and provide an adequate response to new and incumbent nominees who fail to receive a majority of votes cast. Specifically, the governance principles must include the following elements:

• Guidelines that a company discloses in its proxy statement concerning the process to follow for nominees who receive majority withhold votes;
• A clear and reasonable timetable for all decision making regarding a nominee’s status following a majority withhold vote;
• That the process of determining a nominee’s status must be managed by the independent directors (excluding the nominee in question) following a majority withhold vote;
• An outline of the range of remedies that can be considered regarding a nominee;
• That the final decision on a nominee’s status should be promptly disclosed in an SEC filing, including a full explanation of how the decision was reached, and the timeframe for disclosing the decision; and
• An explanation to shareholders why this alternative to a true majority voting standard is the best structure for demonstrating accountability to shareholders.

Even if a company adopts governance principles that meet these guidelines, it does not necessarily follow that ISS will support the board’s recommendation as to a majority election shareholder proposal. ISS noted that it will evaluate a company’s history of accountability to shareholders in its governance structure and in its actions—in particular whether a company has a classified board or a history of ignoring shareholder proposals that a majority of the company’s shareholders have supported.

In December 2005, ISS issued a document in question and answer format to clarify its majority voting policy.¹⁶ In this document, ISS affirmed that it supports a true majority voting standard. It also stated that a majority default rule is the “gold standard by which all other election reform alternatives should be judged”¹⁷ and that the most important element of its policy regarding corporate governance principles that meet its previously articulated guidelines is the requirement that boards of directors explain to shareholders why the alternative to a true majority voting standard is the “best structure at this time for boosting directors’ accountability to shareholders.”¹⁸

What Actions Should Companies Be Taking?

In light of the uncertainty as to the final outcome of this debate, companies should not rush to adopt a majority voting standard. Whether a company’s board needs to take action—either proactive or reactive—on the director election standard remains subject to a facts and circumstances analysis that should consider the host of issues discussed above as well as the size and composition of the company’s institutional shareholder base.

It may make sense for some companies, particularly those facing a majority election shareholder proposal, to adopt a Pfizer-like policy. The policy approach may be sufficient to help a company “win” on a shareholder proposal vote or to buy time to see what trends develop in this area before taking formal action to amend its charter. A policy does not require the approval of shareholders; it can be implemented by the board and, consequently, it can be removed or modified by the board as this issue of corporate governance continues to develop.

Notes

1. SEC Release No. 34-48626 (Oct. 14, 2003), available at <www.sec.gov/rules/proposed/34-48626.htm>.

2. See, e.g., SEC no-action letters to Halliburton Company (Feb. 7, 2005); Qwest Communications International Inc. (Feb. 7, 2005); Verizon Communications Inc. (Feb. 7, 2005); and The Walt Disney Company (Dec. 28, 2004).

3. The letter, dated May 24, 2005, is available on the CII’s Web site at <www.cii.org/library/correspondence/061705_mvfordirectors.htm>.

4. See, e.g., SEC no-action letters to Hewlett-Packard Company (Jan. 5, 2006); American International Group, Inc. (Mar. 14, 2005); Delta Air Lines, Inc. (Feb. 22, 2005); and Citigroup Inc. (Feb. 14, 2005).

5. Institutional Shareholder Services, 2005 Postseason Report, “Corporate Governance at a Crossroads,” at 9, available at <www.issproxy.com/pdf/2005PostSeasonReportFINAL.pdf>.

6. Id.

7. See Institutional Shareholder Services, “Carpenters File Most Majority Election Proposals,” The Friday Report (Dec. 16, 2005).

8. See Institutional Shareholder Services, “Lawyers’ Group Praises Modified Plurality Trend,” The Friday Report (Sept. 30, 2005).

9. See Pfizer, Corporate Governance: Principles, Item 7, available at <www.pfizer.com/pfizer/are/mn_investors_corporate_principles.jsp#voting>; General Electric Governance Principles, Item 20, available at <www.ge.com/en/citizenship/governance/govprinc.htm>.

10. See “Carpenters File Most Majority Election Proposals,” supra note 7, quoting Ed Durkin, corporate affairs director for the United Brotherhood of Carpenters and Joiners.

11. Council of Institutional Investors, “Corporate Governance Policies,” updated November 18, 2005, at 2, available at <www.cii.org/site_files/pdfs/policies/2005%20(November)%20CII%20Policies.pdf>.

12. See SEC no-action letter to Hewlett-Packard Company (January 5, 2006), available at <www.realcorporatelawyer.com/pdfs/DESTINY.pdf>.

13. See American Bar Association, “Committee on Corporate Laws Discussion Paper on Voting by Shareholders in the Election of Directors,” (June 22, 2005), available at <www.cii.org/site_files/pdfs/policies/ABA%20Group%20on%20Majority%20Vote.pdf>.

14. See American Bar Association, “Preliminary Report of the Committee on Corporate Laws on Voting by Shareholders for the Election of Directors” (Jan. 17, 2006), available at <www.abanet.org/buslaw/committees/CL270000pub/directorvoting/20060117000001.pdf>.

15. See Institutional Shareholder Services, “ISS U.S. Corporate Governance Policy 2006 Updates” (2005), available at <www.issproxy.com/pdf/2006USPolicyUpdate111705.pdf>.

16. See Institutional Shareholder Services, “Majority Elections: Questions and Answers on ISS 2006 Voting Policy” (Dec. 2005), available at <www.issproxy.com/pdf/FAQMVPolicy2006.pdf>.

17. Id. at 2.

18. Id. at 4.

About the Authors

Patrick G. Quick (pgquick@foley.com) and John K. Wilson (jkwilson@foley.com) are partners, and Jessica S. Lochmann (jlochmann@foley.com) is an associate, in the transactional and securities practice group of Foley & Lardner LLP’s business law department. The authors would like to thank Benjamin F. Garmer, III, Jay O. Rothman, and David S. Hoeft of Foley & Lardner LLP for their assistance in drafting this article.